Capital flows to emerging market and developing countries have gone through several boom-bust cycles in recent decades, many driven in part by external forces such as monetary policy decisions in major industrialized countries. promoted. During the recent global monetary tightening, capital flows to many emerging market and developing economies have proven relatively resilient, benefiting from strong policy frameworks and healthy foreign exchange reserves. However, some of the most vulnerable countries were disproportionately affected by higher external borrowing costs, as evidenced by the sharp slowdown in Eurobond issuance.
Eurobonds are international bonds issued by countries in a currency different from their own, usually the US dollar or the euro. Eurobonds are primarily used in high-risk emerging market and developing countries. Eurobonds circumvent the limitations of often underdeveloped domestic capital markets, allowing borrowers to access overseas capital and diversify their sources of financing. However, unlike local currency bonds, Eurobonds involve currency risk for the borrower, and their interest rates are particularly sensitive to the monetary policy settings of the issuing currency.
This week’s chart highlights a sharp deceleration in net eurobond issuance by emerging market and developing countries, to $40 billion per year from 2022 to 2023, compared to the previous two years. It decreased by 70%. During this period, 26 out of 75 countries saw net outflows of Eurobonds, totaling $58 billion (including countries such as Bolivia and Mongolia). These outflows were due to maturing eurobonds outpacing new issuance, rather than sell-offs by global investors.
The decline in Eurobond flows reflects a combination of tighter external financial conditions and existing vulnerabilities in affected economies, including fiscal and external sustainability challenges. Some countries with stronger fundamentals and policy frameworks have been able to replace foreign currency issuance with local currency debt, partially financed by domestic investors. Many countries responded by cutting investment and squeezing economic growth to reduce imports. Many countries have also exhausted their reserve reserves, which may reduce their ability to withstand future shocks.
Net Eurobond issuance has a strong negative correlation with interest rates in developed countries, which can be approximated by the 10-year US Treasury bond yield. When bond yields in the U.S. and other developed countries fell during the pandemic, borrowers in emerging market and developing countries took advantage of cheaper borrowing costs and issued bonds.
Then, as the Federal Reserve and other major central banks tightened monetary policy, inflows of Eurobonds dried up in many poorly rated emerging and developing economies as borrowing rates reached exorbitant levels. Despite the widening of the interest rate differential in favor of emerging market and developing countries, Eurobond issuance declined, pointing to the importance of external interest rates for this type of capital flow.
Global interest rate conditions are starting to become more favorable for borrowers this year, as central banks in several major advanced economies have moved to ease monetary policy. This helped eurobond issuance recover to $40 billion in the first quarter of 2024 as countries such as Benin and Ivory Coast return to the market. The start of the Fed’s easing cycle could support a further recovery in eurobond issuance and a broader revival of capital flows to emerging market and developing economies.
